China State Construction Development Holdings' (HKG:830) stock is up by a considerable 10% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on China State Construction Development Holdings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for China State Construction Development Holdings is:

22% = HK$522m ÷ HK$2.4b (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.22 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

China State Construction Development Holdings' Earnings Growth And 22% ROE

To begin with, China State Construction Development Holdings has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. As a result, China State Construction Development Holdings' exceptional 24% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that China State Construction Development Holdings' growth is quite high when compared to the industry average growth of 6.9% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if China State Construction Development Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is China State Construction Development Holdings Making Efficient Use Of Its Profits?

China State Construction Development Holdings has a three-year median payout ratio of 33% (where it is retaining 67% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like China State Construction Development Holdings is reinvesting its earnings efficiently.

Moreover, China State Construction Development Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 37%. However, China State Construction Development Holdings' ROE is predicted to rise to 27% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with China State Construction Development Holdings' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.